by SAMI KARAM
In a new book, Nomura’s lead currency strategist warns that the Euro is on an unsustainable path.
“I wrote this book because I care about Europe”, writes Jens Nordvig in the preface to The Fall of the Euro.
This passion and the author’s scholarship shine through in the subsequent pages. European by birth and living in New York, Nordvig, who is Global Head of Currency Strategy at Nomura, has a unique understanding of the factors that led to the creation of the Euro, and of the impact that the Euro crisis has had on financial markets.
He also has some unsettling insights about the future.
Breakup or Exit
Many people have speculated on the breakup of the Euro. But is a breakup feasible?
Legally speaking, It would be relatively easy for each Eurozone country to redenominate the Euro assets and liabilities which are within its jurisdiction back to its national currency. But, writes Nordvig,
“What would happen to financial assets and liabilities that were outside the jurisdiction of the Eurozone countries if the euro ceased to exist?… What would happen to a loan made in euros by a US investment bank to a big industrial company in Poland? Would the loan now be in US dollars? Would it now be in Polish zloty?… The lender might have one preference and the borrower another. There would be a potential dispute of this nature for every single financial contract…These disputes would be the catalyst for widespread legal warfare…There would be trillions worth of assets and liabilities denominated in “zombie euros” and outside the reach of Eurozone governments… There was no example of this in history.”
If the obstacles to a full breakup seem insurmountable, the exit from the Eurozone by one or several countries look by contrast to be more manageable. Here as with many Euro-related decisions, the outcome will likely be dictated by politics.
Although the weaker countries are seen as likely candidates for exit, Nordvig notes that any benefit they would derive from reverting to their weaker national currencies would be largely offset by the magnified burden of having to service their Euro-denominated debts.
Nordvig also explores the scenario of a German exit, an option which he views as feasible but improbable.
Austerity or Devaluation
A “hard currency equilibrium” has prevailed since 2012 but this equilibrium is entirely dependent on periphery countries (Italy, Spain, Portugal, Greece, Cyprus) sticking to tough austerity measures. In this scenario, adjustment will take several years before a strong recovery can return.
Should austerity prove unsustainable, the Euro may find a “soft currency equilibrium” in which debt limits are ignored and rescue conditions are relaxed. According to Nordvig, this could turn the Euro into a weak currency not dissimilar to the former Italian Lira.
Bond spreads have tightened and stocks have risen since the dark days of 2012 but Nordvig cautions against complacency:
“Investors should be on the alert and not be fooled by the relative market calm observed since the summer of 2012. There is a difference between bond yields that are consistent with fundamentals and yields that have been artificially pushed lower as a result of insurance from the core.”